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There’s Not Just One Meeting

Of late the pound’s taken a beating
Not only is data retreating
But Carney explained
No May hike’s ordained
Remember, there’s not just one meeting

The pound is lower by more than 2% (0.2% overnight) since Wednesday’s high with yesterday’s decline directly attributed to Governor Carney’s most recent comments. While the market had been convinced that the BOE would be raising rates at their May meeting, having priced in a more than 80% probability despite the recently softening data, that all changed when Carney was interviewed yesterday at the IMF meetings by the BBC. He said that the BOE would make decisions “conscious that there are other meetings” at which they could act this year. The market response was immediate, with that rate hike probability falling below 50% in short order. The clear implication was that he no longer feels compelled to act in May. Rather, given the combination of the recently softer data as well as the ongoing Brexit uncertainties (questions about the Irish border issue have resurfaced and are not close to being solved), the BOE is going to be very deliberate in its actions. If you recall, inflation data released earlier this week fell much more sharply than expected and possibly signaled that the impact of the much weaker pound in the immediate aftermath of the Brexit vote may now have passed. At the same time, while the employment situation (a lagging indicator) remains robust, the production and consumption data have continued to disappoint. You know that I have always been skeptical of a May rate hike, which I based on the ongoing Brexit issues, and now it appears that Governor Carney is having second thoughts as well. It seems to me that unless there is a broad based dollar retreat, the pound will have difficulty rallying in the near term.

But the pound is not the only currency under pressure this morning, in fact the dollar is having quite a good day, rallying 0.35% vs. the euro and 0.45% vs. the Australian dollar. Even the yen is lower by 0.25%. It seems that the past week has highlighted some of the impending differences between the US and the rest of the G10, at least with regard to monetary policy. All week the US data has been pretty much on expectations, albeit with a few softer readings. But the commentary from the Fed speakers has done nothing to change the view that they will be raising rates at least twice more this year with a good chance at three more hikes. At the same time, the data we have seen from elsewhere in the G10 has been consistently disappointing, notably the inflation data from the Eurozone, but also IP data, Retail Sales data and survey data. In fact, Bloomberg had an article this morning directly discussing changing perceptions about the ECB’s activities going forward, where they highlighted that a number of economists have delayed their anticipated timing of policy actions. While this is no surprise to me, it is indicative that the market may be beginning to shift the narrative slightly. While the ECB hawks are still keen to end QE and start raising rates as soon as possible, they remain in a minority. Instead, it appears that the ECB will continue to move extremely slowly, even in their commentary, which is likely to delay the first rate hikes further. My personal view is they won’t raise rates before Q4 2019, although most economists are looking for Q2.

What about the inverting yield curve? Well, given the ongoing rise in commodity prices, which are exploding higher across both energy and metals, the back end of the Treasury curve is seeing much greater selling pressure. In fact, this morning the 10-year yield is up to 2.92% and the 2’s-10’s spread has widened out to 49bps. As I wrote yesterday, if inflation continues to perk up, which given the rise in commodity prices seems like an even better bet, there will be limited concerns about an inverting yield curve. Rather, the Fed is likely to sound even more hawkish as they realize that they are falling behind the curve. The upshot is that as US rates consistently outpace those in the rest of the world, I continue to see scope for the dollar to outperform. I understand that there are structural impediments, but in the short run, I would still look to relative monetary policy actions and expectations.

However, one thing to remember is that despite the dollar’s solid performance today, we remain right in the middle of the trading range seen since late January. In order to break from this malaise we will need to see something completely new to the market. Quite frankly, my concern is that the most likely candidate for this type of news would be a re-escalation of the trade war rhetoric, and more damaging, actual imposition of those tariffs on $150 billion of Chinese goods. That would clearly undermine the dollar in the short run, and probably in the long run as well. But that is a story for another day, or at least potentially so. Today there is no such issue.

There is no US data today although we hear from two Fed speakers, Evans and Williams, both of whom appear to be relative centrists on the FOMC. We also have the IMF meetings in Washington, although I don’t believe any statement will be released until after the close. The last piece of data to be released of any import is Canadian inflation, where the market is looking for a 2.4% headline and 1.5% core reading. If you recall earlier this week, the BOC cited the lessening inflation pressures along with moderating growth and production data as reasons to slow their pace of tightening. Today we will learn if their concerns were valid. But otherwise I have to look toward the energy markets, where WTI is testing $70/BBL, for market cues. If commodity prices continue to rally as they have been, inflationary concerns are going to rise quickly which means that we are likely to see Treasuries continue to sell off, equities continue to sell off and the dollar to remain well bid on the idea that the Fed will become even more aggressive. And I see nothing to stop that price action for now.